How Are You All Doing?

We have been in touch with all of our clients, in some capacity over the last couple of months and apart from a few personal issues (not Covid-related), most seem to be in relatively good spirits. Some had to quarantine (some had to quarantine more than once) upon returning from travel or warmer climates. Paul has been able to go into the office, Bianca (sans daycare) and I have hunkered down in our home offices.

We have spent time balancing and re-balancing as market swings have dictated that we should. I have not received anything other than positive feedback. Most client experiences contained limited exposure to some of the potential bigger swings in portfolio value (avoidance of REIT's and preferred shares certainly helped).

Our success in keeping big volatility out has been partly responsible for new clients coming on board. As well, our new clients are joining us because they are frustrated by a "one size fits all" investment portfolio. Concerned that they do not have a tailored strategy, tired of over-paying and worried about advisor conflicts of interest (gathering assets for commissions, rather than providing quality service). As it turns out, the stewardship that we provide gives people some comfort that we know what their goals are and that we can work diligently and carefully to getting them to them.

I am encouraged when I talk to our 20 and 30 something clients, they seem to be developing long-term perspectives and continue to add to their savings and that has been timely for them.

As for me, a little less commuting has turned into a more rigorous exercise regimen (including yoga) and I have shed a bunch of unwanted pounds. Not yet at the point where I could participate in "kilted" yoga (that is never likely to happen), but enough so that I feel a little mentally sharper, despite the lock-down.

To all of our clients who are out on the front lines (you know who you are!), a huge thank you. To any of our clients who just want to chat, you know where to reach me and to anyone who might like a different kind of investing and wealth management experience, we are happy to open up discussions.

To everyone, stay safe and stay healthy. There may be more Covid-19 to come, but being prepared is paramount. Hope for the best, but be prepared for the worst.

The Stock Market Has Become A Casino

For you regular readers of this blog, you know that my ongoing battle continues to be to try and reconcile the current reality of stock market moves with the fundamentals (Price to Earnings ratio for one metric), which (courtesy of Liz Ann Sonders, Chief Investment Strategist at Charles Schwab) has for the last 20 years has had a 90% correlation:

Until March 23, 2020. Remember that day?

Since then, the correlation has been a mirror image: -90%

What?

In other words, stock market buyers have in fact been pushing equity prices higher while earnings expectations continue to erode. 

So who is buying and more importantly why?

I wrote this question in my daily journal on May 12 and have been trying to figure it all out since. I hear on the radio, see it on T.V. and read it in the financial news print: financial advice givers telling us that "investors" are looking "beyond" the current pandemic. Seriously? How far do we have to look? Are these supposed "investors" expecting a return to normal? Even the U.S. Federal Reserve Chairman Powell has warned that this is going to be tough economic time for quite some time into the future (and he is normally rather optimistic). The Fed (along with the BOC and other central banks) has pushed plenty of liquidity and almost 0% interest rates on us. Some might say that their policies are forcing investors into stocks as the only alternative.

In his morning research that our friend David Rosenberg sent a couple of days ago he posed the exact same question: "Who are the people doing the buying?"

And then in yesterday's note it became rather clear:

"We know from the fund flow data that it isn't the general public. We know from the BAML survey it isn't institutional investors. We know that from the CFTC data that it isn't the hedge funds. If I told you who the people are that are bidding equity prices higher you wouldn't believe me."

But an article in the Financial Times may have shed some light on the subject: "Frustrated Sports Punters Turn to U.S. Stock Market" :

"Gamblers who cannot bet on professional sport because fixtures have been scrapped are flocking instead to the US stock market, creating a new class of customer for online brokerages and adding fuel to the market rally."

Sure, there have always been gamblers trading stocks, but now there a whole lot more of them and from that the risk in owning stocks becomes that much more egregious. 

As David said in yesterdays briefing: "Hundreds of thousands of frustrated gamblers have shifted from on line sports gambling... this is infinitely worse than the cab driver giving you stock tips, which in the past was always a sign of a speculative market top".

My friends, I believe that we may need to prepare ourselves for a whole lot more volatility before this is all over. Certainly, when you hear financial media commentators calling stock market participants "investors", you are going to have to think a little harder on that.

Be safe, stay healthy!

Set Your Goals

The crystal ball is a bit cloudy at the moment (for some that may be a bit of an understatement), so it is a great excuse to put off setting (re-setting) our goals. We had a good look at and discussion about procrastination in my ongoing Friday sessions last week, courtesy of my friend and coach Greg Wood. One of the key takeaways was the idea that: "if you are standing still, you are not moving forward". Certainly the current life-situation on the back of the ongoing pandemic in which we find ourselves is definitely a cause for concern and likely making us take a good hard look at our life priorities, but we cannot stay in paralysis forever, we have to keep going and we will. Those who get on it more quickly are those that are likely to benefit the most.

I enjoy the conversations with our younger clients who are most eager to get back to building their compounding curve. With 50 to 60 (or more) odd years in front of them, they can afford to be taking a little more risk.

I can't help but be motivated by their attitudes toward building their wealth and their future.

However, we all do not have the same time horizon's, so it is important to pull out our plans (at High Rock, we call them Wealth Forecast's), take a good look at how they are structured and note what adjustments may have to be made. Everybody's circumstances are different: building our wealth or utilizing our wealth, we need to assess our current circumstances and take a good hard look at our expectations of return as a function of the risk that we are prepared to take on.

That is why a "one size fits all" kind of strategy is only to the benefit of the advisor who cares more about building her / his practice for scale and revenue rather than addressing the needs and goals of their clients (in my opinion, an enormous conflict of interest). Anybody who has been / is still over exposed to Canadian preferred shares or REIT's will understand that. 

So it is time to reassess. Perhaps set out your lifeline: ask yourself where you want to be in 1 year, 3 years, 5 years, 10 years and so on. Set your goals and prioritize them (they may not necessarily all be financial goals).

Optimism Sells. Be Careful What You Buy Into

How many times have I heard about financial advisors (almost, but not quite promising) stating that annual average returns in the 7% range are pretty easy to achieve? Conveniently forgetting to remind us that past performance is not a guarantee of future performance.

Yesterday, White House officials (Mnuchin, Kudlow, Hasset) were on the airwaves talking about an economy that will bounce back in the second half of 2020 and have a "tremendous snapback" in 2021. Meanwhile, Fed official Neil Kashskari "wishes" it were true, but expects a slow, more gradual recovery. The National Bureau of Economic Research has a working paper that is suggesting an "L" shaped recovery. Our friend David Rosenberg thinks it will be more of a "W" shaped recovery. So what's it going to be?

My natural skepticism suggests those least likely to have an agenda may be closer to the reality of the circumstances. Like Kashkari, I too wish for a strong economic bounce back, but to be honest and fair to myself and our clients, we need to be prepared for some disappointment.

Despite being told often enough by presidential tweet that stock market strength is representative of a great economy, there has been an increasing disconnect between the two. So frequently, lately, have I heard the optimists and "cheerleaders" tell us that the stock market is "forward looking". How far forward is it looking? would be my next question.

Factset, the folks who supply us with earnings data and estimates (remember earnings? one of the metrics, supposedly, for analyzing a stock's value) suggest that the current stock price to  forward (12 months estimated) earnings (P/E) ratio has not been this high (expensive) since 2002:

Forward earnings guidance by many (about 40% of) companies has been pulled as the crystal ball has gone particularly cloudy, so the "E" in the ratio is a "best guess" for analysts. For those of us who still care about fundamentals, that means that anyone buying stocks at this point is likely tacking on some pretty hefty risk.

David Rosenberg did remind us this morning: "Equities have become little more than a casino, with central bankers as the blackjack dealers as they do all they can to support the investment community".

For a deeper dive on the disconnect between stocks and the economy, the New York Times had this article: Repeat After Me: The Markets Are Not The Economy : "For decades, the market has been growing increasingly detached from the mainstream of American life, mirroring broad changes in the economy".

"So why do millions of Americans continue to think the market really is a barometer on the economy? That's more a question of history and culture than economics".

If you have a portfolio that is 60% equity, you may be gambling  (vs. investing) a little more than you are lead to believe and the downside risk may be growing. Optimists tend to downplay the risk factors. Not that you should not have risk, we do need to take risk, but you need to be aware of what risk you have and how it may impact your investment portfolio, especially when markets are negatively impacted.

Our philosophy at High Rock has always been to manage risk first. That is one of the features that makes us different and better from those who just want to sell to you (their agenda). Our agenda is to invite clients who want that kind of risk-adjusted portfolio  management.

As I suggested in my blog "Won't Get Fooled Again", it may be worth looking at your risk profile and trying to determine if, perhaps, you might want to revisit your investment risk, given the current circumstances. The time is now, while the stock market is strong. You don't want to be making these decisions when the market starts to reassess value and risk. Always happy to offer an opinion directly.

Happy Birthday High Rock Private Client (Wealth Management) Division

It is actually a bit belated, but with all that has been going on recently it actually had slipped my mind until I was asked a few questions by a prospective client this morning which I will share further along in this blog. We were supposed to celebrate with a gathering of our clients, prospective clients and friends at The Albany Club (across King Street from our office at 1 Toronto Street) yesterday evening with a special guest appearance from our friend David Rosenberg. Given the current pandemic and subsequent lock-down, the timing (planned well-before this all happened) was not so good. In hindsight, though, I would really like everyone to hear David's outlook on the current reality that we face. David's input and critical thinking was, over the last year, vital in helping us maintain a defensive strategy that has been paramount for our clients avoiding the huge swings and frightening volatility of the last couple of months. 

As of yesterday, our 60% fixed income, 40% equity clients were basically flat on the year (this is general, because every client portfolio and strategy is specifically tailored to their own situation: goals, time horizon, risk tolerance). The 40% fixed income, 60% equity clients somewhere between -2% and -4% on the year (again depending on their asset allocation mix). And, as you all should know, historical returns are not a guarantee of future performance.

So while we don't like how history has unfolded thus far in 2020, we can quietly celebrate keeping volatility to a minimum in our client portfolios, despite the crazy market swings (which, as you may have guessed, if you read my little blog regularly, are likely not over, or at least that's what we think, anyway). You can believe in the optimist's  narrative touting a "V" recovery and we sure hope that they are right! They appear to be looking beyond the recession. However, even the sometimes overly optimistic U.S Federal Reserve said yesterday that 

"the ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term".

Medium term friends, to me that is 3-5 years. So we think more of a "W" recovery. It might be best not get too comfortable in the first "V".

Back to High Rock:

Q:  When did you start High Rock?

A: Paul started High Rock in 2010 as an institutional portfolio management company, managing (sub-advising on) 4 mutual funds for Scotia Bank. We started our Private Client Division in 2015 (I bought ½ of High Rock at that time). Our bio’s are on the website highrockcapital.ca/team for further detail. We both shared a similar philosophical rationale for molding a wealth management firm that was more client focused vs. the “one size fits all” approach, specifically because we felt the former was better and different than the industry direction that is moving towards scale, favouring shareholders and commissions over client advice and service.

Q: What alternative strategies do you use besides Fixed Income and Equities?

A: We are very focused on liquidity for our clients, which allows us to maneuver quickly when we need to (and provide cash flow to clients when they need it). We have owned REIT’s in the past, but are a little skeptical of their distributions (Paul is very cash flow focused with his research on any company we own that pays income or dividends). Turned out to be a good thing as they got clobbered recently. When the time is right we may look at them again. Private Equity and other forms of real estate ownership tend to be less than liquid. I would be happy to discuss our Tactical model strategies in more detail if you wish.

Q:   I think as we navigate this economic turmoil and COVID ; It is clear we have a simple objective nothing fancy like you spoke about knowing they can sleep at night and while there are ups and downs that are beyond anyone's control but the ship is actively managed and while we may not hit homers we are often more right than wrong with singles .  Wealth management with the ideal goal would be 7-8% interest annually manage the down side and understand there is a sacrifice on the upside. 

A: Historically, 7-8% was achievable. Believe me, I would love to get back to those days. But for the near-term anyway, I would suggest that with interest rates near 0% and economic growth likely to be no better than 2% over the next few years, getting 7-8% might be fraught with higher levels of risk (that would make sleep less easy to come by). It is doable, but for my own portfolio I would not want that level of risk, so I would ask the risk question first because everything we do is about managing risk first. Return per unit of risk taken / or risk-adjusted returns. I think that once we get to the other side of Covid-19, I would be cautiously optimistic of getting back to 6-7% as inflation returns and yields move higher, but that may take a while.

Q:   We are realizing that Pooled funds may be less our appetite; not portable, less transparency and hard to be fully tax efficient 

for both our corporations and personal

A: We utilize the Separately Managed Accounts (SMA) to help harvest tax losses when they are available to offset gains. Everybody has tax strategies and we find it helpful to align ourselves with their tax professionals to ensure a seamless and synchronized strategy. It also helps us to direct client holdings to more tax efficient accounts when it is available. i.e. higher income (less tax efficient holdings) to tax free and tax deferred accounts when available.

Q:   How active are you in the portfolio ?  in changing positions/ rebalancing etc.

A: There are 3 reasons for rebalancing:

1) Cash flow in

2) Cash flow out

3) Price adjustment in holdings (that take % allocations out of the desired range).

These can be ongoing and tend to be client specific (which is why we also prefer SMA accounts).

Changing positions is tactical and we will do so when we get what we consider to be a good opportunity. For example: We took Global Equity Model positions to under-weight in 2018, added some back in early 2019 (perhaps not enough though) and further reduced in 2019 (profit-taking), simply because markets looked expensive. As markets fell in 2020 we started to add some back, gradually. Yesterday we started to sell (we will sell more if markets continue higher). Taking advantage of volatility is one way to add alpha (earn our fees).

Q:  How many different iterations of portfolios exist — I recall you talking about a bespoke approach and the returns of I believe your portfolio from the presentation  typical of the  avg high rock client ?

A: We have three basic models (and some “special opportunity” models for more sophisticated clients): Fixed Income, Global Equity, Tactical. I would be happy to go into greater detail on a call. But each client family, (RESP’s and children over 18 have their own strategies) has an allocation of the 3 basic models. The structure of that allocation is based on a combination of the client families goals, time horizon and risk tolerance as set out in a Wealth Forecast and then strategized in an Investment Policy Statement (IPS) that we advise on and determine in conjunction with you. These are target ranges that give us some latitude for tactically building and managing the portfolio. Paul has the greatest weighting in the Tactical model at 25% (which he runs). I am set up at 40% Fixed Income, 45% Global Equity (which we manage mostly from a macro perspective) and 15% Tactical.

I love what I do!

Won't Get Fooled Again?

With apologies to The Who.

Risk tolerance. 

If your investment portfolio dropped 20% or possibly more and you were feeling quite nauseous back on March 23, you may want to use this opportunity to take a quick look under the hood (ask your advisor to send you an updated portfolio return summary) and ask yourself if you can stand another bout of that?

If you can, read no further.

If you can't and are thinking about the big risk inherent in "re-opening" the global economy, then perhaps it is time to give it some thought.

I am hopeful, but only cautiously optimistic. Think about it, the economy suffered a vicious sudden stop. Pretty much everything shut-down. There is no switch-click that will just turn it back on again so that it resumes growth (which had already been slowing before the pandemic and lock-down took hold). This re-start will be gradual and fraught with the possibility of another sudden stop. 

Clearly, the mood of the consumer is going to be somewhat skeptical, for some time to come. The only thing that gets the above table anywhere close to normal is if testing and ultimately a vaccine is available for everyone. 

Stock markets, however, appear to have a different perspective. The S&P 500 is up close to 30% from the March 23 lows. Historically, that would be considered a couple of good years.

Let's once again look at the fundamentals: 

Earnings estimates are crashing and expected to continue to show negative growth into 2021:

 If stock prices are rising and earnings are tumbling, anyone want to take a wild guess as to what is happening to the ratio of prices to earnings?

Yup, spiking back to the February highs, higher in fact. Remember what happens next?

What this tells me is that risk is also spiking, as it did in January and February. If your portfolio has too much risk and your tolerance for it is not there, it's a good time to make some adjustments.

High Rock Private Clients remain underweight equity and overweight cash equivalents, unless of course you are a daring millennial (we do have some young folks as clients with very long time horizons) who is comfortable with the risk.

If you need cash flow for retirement purposes over the next few years, think long and hard.

Inflation's Sting May Return (But Not Quite Yet)

$8 Trillion!

From our friend David Rosenberg this morning: "Why aren't markets getting hit even more (as in equities)? ... Governments around the world have stimulated so much, that's why. Just on the fiscal side alone, not including all the incursions by central banks alone to influence and support risk-asset prices, the global stimulus has come to an astounding $8 trillion."

This is going to make the Bank of Canada's inflation projections (as I suggested in Tuesdays blog) go squirrelly!

From the BOC's April Monetary Policy Report:

"The weak economic outlook will weigh on inflation. Because of severe and adverse effects of the pandemic, there is considerable uncertainty around the outlook for inflation. Determining the impact of the economic contraction on future inflation is difficult because both supply and demand are falling. There will also likely be technical challenges to measuring inflation during the containment period."

Gas and other energy related prices have fallen precipitously, especially those pertaining to transportation and travel (hotel costs too). Likely food and medical prices have risen on scarcity and perhaps delivery costs, although with folks no longer dining out, that could be a wash.

But, what happens when the recovery comes (and how sustainable it might be)? All that stimulus sloshing around is going to impact the value of our money. Already it can be seen in the little watched (anymore) money supply numbers:

Back in the late 1970's / early 1980's when inflation was peaking at 9% annually (only those of us over 60 likely remember this era) this was a key data point and we currency, money market and bond traders waited for the weekly reports in order to assess the central bank's next likely interest rate move in their raging battle against inflation. Higher levels of money supply in the system were considered inflationary, prompting expectations of central bank tightening of monetary policy (higher interest rates).

We are going to start to need to keep an eye on this again because of the potential for it to sneak up on us. Central banks money printing presses are running on overdrive.

History tells us that after recessions, inflation will inevitably return and become the next worry. The last thing highly indebted economies need is a surge in interest rates to combat the upward inflationary pressures. Bond and fixed income investors will demand inflation premiums to be built into yields if they perceive erosion of purchasing power in the future. The big debt load put on governments who will be borrowing to finance the $8 trillion in stimulus will also add to long term interest rate increases. The market will determine the level of interest rates, but it would have implications for mortgage rates too, as they are set off of what happens in bond markets. 

If safer investments provide a better return than riskier stocks, where will aging investors feel more comfortable? 

It is also going to challenge the central banks whose mandates are based on controlling inflation (the value of their currency).

How this plays out is far from certain, but it could have significant consequences for all of our collective Wealth Forecasts should we have to ramp up our assumptions surrounding our annual cost of living increases.